Khan Academy AP Mac Unit 1 Lesson 3

Comparative advantage and the gains from trade

absolute advantage

the ability to produce more of a good than another entity, given the same resources. For example, in a single day, Owen can embroider 10 pillows and Penny can embroider 15 pillows, so Penny has absolute advantage in embroidering pillows.

comparative advantage

the ability to produce a good at a lower opportunity cost than another entity. For example, for every pillow Owen embroiders his opportunity cost is scarves knitted, while Penny must forego scarves for every pillow she embroiders, so Owen has comparative advantage in embroidering pillows.

specialization

when an individual or a country allocates most or all of its resources towards the production of a particular good or service. For example, Sal (an individual) specializes in producing educational videos, and Bangladesh (the country) specializes in producing textiles.

trade

the exchange of goods, services or resources between one economic agent and another

international trade

the exchange of goods, services, or resources between one country and another

gains from trade

the ability of two agents to increase their consumption possibilities by specializing in the good in which they have comparative advantage and trading for a good in which they do not have comparative advantage

terms of trade/trading price

the price of one good in terms of the other that two countries agree to trade at; beneficial terms of trade allows a country to import a good at a lower opportunity cost than the cost for them to produce the good domestically, thus the country gains from trade.